Budget paves the way to resolve MSME dues

The Parliamentary Standing Committee on Finance, which consists of members from across all political parties, in its report of last April highlighted the importance of micro, small and medium enterprises (MSME). There are an estimated 64 million of these, and nearly ninety nine percent of them are very small, micro or tiny. These MSMEs are among the ones that employ less than five persons, and whose annual turnover may not even be 20 lakh rupees. Their importance to the economy can be gauged by the following: As per the Standing Committee, the MSMEs contribute 30 percent to the national GDP, 45 percent to the national manufacturing output and 48 percent to exports. They together employ 11 crore people, which is 42 percent of all industrial workers.

There is rarely a system where some advance payment is made to the supplier which can then be used as working capital

Despite the economic significance of MSMEs to employment, output and exports, they only get a small share of bank credit or any formal credit.  The Standing Committee says that their funding gap is 20 to 25 lakh crore. Their funding requirement is most often in the form of working capital. That’s because the small businesses are mainly vendors, suppliers and ancillaries to large corporations, be they public or private sector. They may be providing some spare parts, or packaging service, or what is called “job work”.

These small vendor supplier businesses have complete dependency on their customer, and many have only one or two customers. For instance, the Indian Railways is supposed to have one million suppliers, and for most of the suppliers the Railways is their only customer. Think of those who supply earthen cups (kulhaad) for tea, or napkins and towels, steel fabricated parts, or food packets to railway canteens and so on. 

The same is the fate for most MSME’s who have one or two major corporations as their customers. There is rarely a system where some advance payment is made to the supplier which can then be used as working capital. And after the product or service has been delivered, the MSME law states that no customer can delay payments for more than 45 days to the vendor. This is a protective clause because of the extreme financial vulnerability of the MSME.  But in practice it is rarely enforced. The bane of the MSME is delayed payment.

Despite delayed payments, the big corporations take advantage of input tax credit paid by their vendors when they file their GST returns

The reason the large corporation or customer can get away by not paying within 45 days, is because the invoicing is not proper, reliable or valid. It could be a proforma invoice, preliminary bill or “rough” paperwork. So technically payment delays can be indefinite. By one estimate the problem of delayed payment is as large as 10 lakh crore. This is the aggregate amount owed to all MSME’s on a national level. Imagine if the delay is for say 12 months, then the interest cost itself is 1 lakh crore in the aggregate. If the delayed payment problem is addressed then it will release 1 lakh crore as productive capital, without any subsidy from the government to the MSME’s.

The GST network data is a rich source of data for lenders to finance the MSMEs

 How can customers be forced to pay their MSME suppliers in quick time? We don’t want to unleash an inspection Raj.  The problem has been recognised for quite some time. In 2018 the Reserve Bank of India set up an online platform called the Trade Receivables Discounting System (TReDS) wherein the receivables of MSME’s can be put up “for sale” i.e. also called bill discounting.

So, if an MSME has 100 rupees due from say XYZ Corporation, someone can pay off 97 rupees to the MSME and then go pursue the big company XYZ for the full 100 rupees.  The transaction does not have any “recourse” to the MSME once the receivables right has transferred. The success of TReDS requires onboarding of a large number of buyers (large corporations) and sellers (MSMEs). Only then can the bill discounting business take off. But that has met with limited success, since many large companies simply do not want to come on to the platform.

Even public sector companies are reluctant. Neither the RBI nor the government is able to enforce this discipline. Another method was devised in the State of Tamil Nadu to put up names of “defaulters” on a government portal. But this requires the MSME vendor to “complain” i.e. name and shame the customer. Which right minded small vendor will want to anger their only lifetime customer in such a way? So, the name and shame method is also not working.

 Here comes the importance of GST. The fact is despite delayed payments, the big corporations take advantage of input tax credit paid by their vendors when they file their GST returns. Among the recent budget proposals there is an amendment to section 43 B of the income tax Act. This amendment disallows any deduction to the large corporate, unless the payment to the MSME has been actually done. You can’t claim tax credit and not pay your vendor on time. This is a great step ahead although it needs cooperation at the State level to become fully functional.

More importantly the GST network data is a rich source of data for lenders to finance the MSMEs. Since the transaction has been recorded on GSTN (even if the actual payment is delayed, the lender bank can provide finance to the MSME on the basis of GSTN data. This is called cash flow-based financing and is not against any physical collateral. Since the payment is due from a large corporate the bank can get a good assessment of the payment risk. The GSTN approach has several advantages. It encourages MSMEs to come into the GST net (many were reluctant earlier). It makes the data transparent, and can also put the defaulters and delayed payments in the spotlight. It brings more formal finance and credit to MSMEs. It also encourages the MSME to go fully digital, i.e. not just for their receivables and accounts, but also for the enterprise, including inventory control, payroll etc. The cost of going fully digital using off the shelf ERP software packages is declining and is affordable. Even banks will nudge their MSME clients to go digital in this way.

Unlocking the value in delayed payments to MSMEs can give a big productivity and positive income kick to the economy. The GST network will play a key role in this.

(Dr. Ajit Ranade is a noted economist)